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Introduction

This week's letter comes to us from my friend Barry Ritholtz, Chief Market Strategist of the Maxim Group and a frequent guest on CNBC and Fox. I have been reading his commentary for several years and he now keeps a Blog called The Big Picture.

The following is a combination of two commentaries about government economic numbers. It is hard to rely on statistical numbers if the government periodically decides to change how they are calculated and Barry takes a look at several statistics. Plus he shows how data can be graphically presented to make the same numbers look completely different, one way positive and the other negative. This is certainly Outside the Box material I hope you enjoy.

- John Mauldin

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Juiced Data

We have been watching, with no small degree of skepticism, a stream of improving Macro-economic data. Color us unconvinced. Many of the key releases have been fraught with misleading headlines obscuring much weaker data beneath, and last month was no different. From Inflation to Federal Deficit to Unemployment Rates to Industrial Output to recent GDP (and its revisions), nearly every data point comes with an asterisk.

When we look back at this period of economic home runs, we will call it the season of steroids. Like Major Leaguers, the Data is on the Juice.

Take the Leading Economic Indicators (and revisions) from the Conference Board. The changes to the LEI now register a flattening yield curve as a positive for future economic activity. Only in the alternative universe where the Conference Board lives is this considered a positive. The CB now requires the yield curve to actually invert before it bodes negatively for future economic growth.

The Board was apparently not pleased that 8 of the 10 past LEIs were negative. Hey, if you don't like what the indicators are suggesting, than why not just change the model? And that's exactly happened. Taking a page from the BLS handbook (Birth Death adjustment, anyone?), the Conference Board reduced the utility of LEIs for investors. Their work now falls into the category of economic cheerleading.

Kindly return your Pom Poms to the gymnasium at the end of the semester.

Don't care much for that private group? Then consider what BEA hath wrought. Their GDP revisions for 2005 Q1 border on the absurd. In order to crank GDP from its disappointing initial reading of 3.1% to the more vigorous final 3.8%, the BEA had to make some sketchy adjustments. Primary amongst their changes was (I am not making this up!) an actual decrease in Home Prices for Q1. Thus, by somehow emphasizing unit sales (as opposed to price appreciation), courtesy of the Price Deflator, GDP became higher in the final read.

Torture the data long enough, and it will confess to whatever you want it to.

Despite this gamesmanship - or perhaps because of it - much of the investing public knows only half the story when they read the economic headlines. The challenge to us is to not only attempt to discern reality, but to anticipate when the great masses do so also. It's what has caused us to title research in the past with phrases such as "Fundamentals Stink: Buy Stocks." When the charade finally ends - probably after the last of the Bears capitulates - the finale will be ugly.

(UPDATE: August 2, 2005 9:43pm)

A few quick points: When GDP is calculated, one of the components is Structures (Residential). That's the line where the new home construction supposedly dropped in price. The data comes from Census (part of BEA). Here is the relevant line from the Technical Note, under "Sources of Revisions":
Investment in residential structures was revised up, mainly on the basis of a downward revision to the Census price index for single-family houses. (Emphasis Barry Ritholtz).
If prices went down, unit production went up. So not only do we have more output (units built), but since prices theoretically declined, the price deflator does its thing. Voila! GDP revised from 3.1% to 3.8%! (Hey kids, its magic)

Note also that part of GDP measures new -- but not existing -- home sales. The transaction of shifting title from one party to another isn't considered production (nothing gets made), while building a new residential structure is.

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GDP Revised Downwards

I was out on Friday, so I didn't get a chance to review the GDP revision in the BEA release (I take one day off, and that's what happens).

Here's the official announcement:
For 2001-2004, real GDP grew at an average annual rate of 2.8 percent, 0.3 percentage point less than in the previously published estimates. The average annual rate of growth of real GDP from 2001:IV to 2005:I is 3.3 percent, 0.2 percentage point less than in the previously published estimates. Revisions to year-to-year growth rates were small.

Revisions to 2002-2004 estimates

The percent change from the preceding year in real GDP was revised down for all 3 years: From 1.9 percent to 1.6 percent for 2002, from 3.0 percent to 2.7 percent for 2003, and from 4.4 percent to 4.2 percent for 2004.
Those are pretty hefty downward revisions of 0.3%, 0.3% and 0.2% per year.

Bottom line: The tendency is for the initial read on GDP to be revised upwards in the subsequent 2 releases (Advance, Preliminary and Final), and then ultimately to be revised back downwards (closer to reality) -- at least in this post-recession cycle; I haven't gone back over the historical numbers far enough to conclude whether this has occurs in this order traditionally.

As we discussed above in Juiced Data, if you massage numbers long enough . . . well you know the rest. But the same applies to charts: Depending upon the scale you select to use, your choice makes the revision look more or less significant:

Bad:

Chart courtesy of ArgMax

Not so Bad:

Chart courtesy of Northern Trust
(The full data can be found at BEA)

Here's the tell: Anyone who relies upon the initial read is likely to have a below consensus expectation for growth; those who rely on the 2 subsequent revisions, will expect above consensus growth.

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Conclusion

I hope you enjoyed this exploration of economic statistics and data presentation. You can see the original report and other commentary by Barry Ritholtz at http://bigpicture.typepad.com/

Your watching how the data is presented analyst,


John F. Mauldin
johnmauldin@investorsinsight.com

Disclaimer

John Mauldin is president of Millennium Wave Advisors, LLC, a registered investment advisor. All material presented herein is believed to be reliable but we cannot attest to its accuracy. Investment recommendations may change and readers are urged to check with their investment counselors before making any investment decisions.

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Posted 08-08-2005 2:20 AM by John Mauldin